what's a net worth

when i used to think about retirement, i used to think that i'd need to have a net worth of about 2 million bucks. i figured that with a 5% rate of return, that would net a cool hundred grand a year to live off of in retirement -- that a $100,000 a year would be sufficient to meet my standard of living. in reflecting on this, i realized that what i was concentrating on was income, which is something that we naturally think about. in our working lives, we try to make as much as we can. in thinking about retirement, though, i've been trying to shift my mentality. instead of thinking "i need 100k a year to retire", i've been trying to arrive at the amount that i would spend in retirement to live. if my income can cover my living expenses, that would allow me to retire. that income could come from any number of sources -- in my previous way of thinking, it was investment income of some sort off of a $2,000,000 nest egg. the realization to me here is that you don't necessarily have to have a hefty net worth to retire.

this realization has come relatively recently, even though it's quite obvious when you stop to think about it. through the years i've been pretty diligent about tracking our net worth every few months, and i'm not saying that knowing your net worth isn't a valuable thing, but it can be misleading. if you are not paying close attention to your cash flow, your net worth can quickly be eroded away. moreover, your net worth often includes real assets (like property) that can give you a sense of wealth that is imaginary, or at least very hard to tap into to cover expenses.

so, now i'm trying to concentrating on cash flow, and more specifically our monthly expenses. by tracking that and similarly tracking passive modes of income, we can see how close we are to a break even point. in my mind that break even point is the event horizon for retirement.

reboot

i've been purposely anonymous (not just by name, but also in not divulging my age, profession, income, etc.) in my writing on this blog from the beginning because i felt that would allow a broader audience to read my posts.

an interesting thing happened the other day that made me rethink this approach, and made me think that i should narrow my focus and write with a very specific and personal audience in mind. you see, i was having lunch with a co-worker and the topic of goals, retirement, and the like came up. now, here's a guy i respect very much, who is about the same age as i am, about the same income level, and for all practical considerations, we could be practically twins on paper.

when the talk moved to retirement, i shared with him that my goal is to retire or semi-retire by the time i am 45 years old. i am currently 36. he was a bit shocked, and floated a big question my way: "what's your secret?"

i was perfectly honest with him. i don't have any secrets. for the most part, i am a pretty normal guy. i have not had any big windfalls occur in my life. i have not made a ton of money in stocks or real estate. i did not come into any family money by birth or inheritance. i am not an entrepreneur. i do not own my own company. i am a hard worker and make a decent wage.

there might be some small things that may separate me from my co-worker. i have never carried any credit card debt. i did not take out any student loans. the only debt that i have ever carried is mortgage and car loans. i have been an aggressive saver most of my working life.

i am married and my wife and i were dual income / no kids for about 7 years. my wife is now part time and we have 2 kids -- a one year old and a three year old. we live in the suburbs some 20 miles north of dallas, texas, in what is for most respects our "dream house".

i used to think that i'd need 2 million dollars to retire, but these days i feel like retirement or semi-retirement can be accomplished with far less. i could be dead wrong. but, this is what i am going to write about.

retire young

years ago, i decided that i wanted to retire young with a nest egg that i could reasonably live off of for my remaining years. well, i've decided to look back now to see where i was and how far i have left to go. i've never been fond of sites that post up net worth numbers or things like that, so i'll try to speak in generalities.

one key thing that i aim to achieve is for my investment/passive income to surpass my expenses. at that point, i'll feel comfortable quitting my day job, even in the face of rising inflation. currently, because we have a pretty substantial house payment, that horizon is out pretty far.

from about 2001 til now, our household income has more than doubled, but our housing expense has followed that increase in income -- but not exactly in the same scale. our liquid net worth from that time until now has increased about 10-fold. thanks largely to the increase in income and continued saving and investment.

of course, back in 2001, i was expecting to retire in 15 years. now, at about the half way mark to that goal, i just wanted to take some time to reflect -- without looking at lots of figures and stats -- to see how realistic it would be to retire in 7 years. just ballparking it, i'd say it would require some pretty aggressive measures to make it happen, but it would not require a lottery winning experience.

if we stay the course, i would say just from a back of the napkin type calculation, that we could achieve the break-even point somewhere out about 10 years, at which point our amassed principal might just be enough to produce an income stream approximately equal to our current expenses. so, i would say that we're not far off, especially considering that i am being very conservative in my approximations.

but, what it took to get to this point was to achieve a level of automation in my life that takes decision making out of the saving and investment process and to never waver from that.

dinner conversation

we had dinner with some friends last night and one of them made a comment: "you know i think you guys are probably like us. we don't have a whole lot in savings, we have some in retirement, and got some credit card debt . . . ". i don't recall where the conversation went from there, but i thought it was a pretty accurate picture of the average american.

well, i didn't correct him and tell him that we have a fully funded emergency fund, save and/or invest a good chunk of our take home, and carry no debt except our mortgage. i really don't know how i was instilled with this sense of right and wrong when it comes to my finances -- i suppose it must have been my upbringing, but it really is alarming how the everyman must live.

the way people spend, i have no idea how we, as americans, can afford to retire. are we banking on social security? are we going to work forever? win the lottery?

passive income

i'm interesting in how to generate passive income. that is, income that you can pretty much rely on without having to work. an example of this would be interest income -- if you have $100,000 in a bank yielding 5%, you'd net $5,000 per year without having to do any work at all. Of course, that's a lot of cash to be sitting around idly.

the point of having passive income streams is that at some point, if you've got enough money in the right places, is that you can live off your passive income entirely. this is the point that i call my retirement horizon -- if i can achieve that, it'll likely be goodbye to my 9-to-5. i'll probably still work to some degree on projects that i'm particularly interested in, to keep busy, that type of thing.

but to really know what your retirement horizon is, you have to have a clear picture of what your spending is and what you expect your spending to be. i don't keep too tight a budget, so i only have a general idea what this amount is, but since retirement realistically is a long way off for me, i don't spend too much time fretting about it. my bank does a nice job of displaying a spending report, but that includes transfers into other accounts as spending, so it distorts the amount of 'spending'. it does a decent enough job to show a general guideline, though.

early retirement

i've been thinking about retirement a lot recently. i'm a ways off in terms of normal retirement age, so there are probably more variables for me to think about than your typical retiree. what it comes down to is whether my savings and investment return will be able to at least break even with my spending. since i would be an early retiree, there are some things that i need to consider that other retirees may not have to worry about:

1. mortgage. we recently built a new home and while we did put down 20% on it, we are nowhere near owning our home free and clear, so that means that i'll have to cover my mortgage from savings and/or investments. i don't know about you, but the notion of doing that just seems wacky to me. if i were realistically considering retiring tomorrow, i'd really have to put a lot of thought in selling the house and moving into a place that we could easily afford the mortgage or rent on.

2. college savings. we have a new addition coming into the family soon, and i was planning on saving toward college. i'd have to be able to fund that.

3. medical expenses / insurance. we currently have insurance through our employers, a large portion of which is paid by our employers. something else that would eat away at our savings.

4. a longer timeline. i'm relatively young, so i'd have to cover another 10, 20, or even 30 years more than the typical retiree.

just adding these few things up in my head, i'd be pretty comfortable with about a million dollars in pretty safe and pretty liquid investments to retire tomorrow. so, by the sounds of it, it'll be back to work for me -- at least for another few years.

retirement horizon

so, i've been thinking about retirement, but i'm nowhere close to the standard retirement age. i imagine -- and i have a pretty vivid imagination -- that it might take me anywhere from 5 to 10 to 20 years to build up the savings and investments that we would need to retire. but, why the big range? well, it's all about a standard of living in retirement. i imagine (again, don't forget about my vivid imagination) that we could retire today if we drastically downsized, took the occassional part-time, temporary, or contract work, really lived frugally, and gambled our futures by neglecting medical, life, and other insurances, but that's not really the type of living that i think i'd enjoy in retirement.

i've punched in some numbers on various online retirement calculators, but arriving at a 'what do i need to retire' amount is a problem that's bigger than the sum of its parts.

for one, there are a lot of unknowns -- what age do you want to be when you retire? well, the sooner the better is probably the answer for a lot of people, but that begs the question -- what's the soonest i can retire? that depends on what your income requirements are in retirement, the rate of inflation, the return on your investments, and how long you'll live. these are not the easiest things to arrive at, especially if you're not close to the traditional retirement age.

let's say you have got all these things answered, or at least approximated. that means you have a total dollar figure that you need to retire and a withdrawal rate that will allow your money to outlive you. well, next that means that you have to plan on how to position your investments so that you can safely earn the return you expect from the previous exercise while minimizing risk and having at least some part of that liquid enough so that you can draw from it.

even if you've got all that figured out, you have to account for some level of risk -- medical surprises, downturn in your investments, spiking cost of goods, any number of things that could throw a monkey wrench into your plans.

in the face of all that, people do it every day -- not millionaires -- normal people retire everyday. so, take a deep breath and smile, it can't be all that hard if everyone's doing it. just wait and see -- here in 5, 10, or 20 years, we'll be one of them!

retirement

so, my parents are retired and they live in about 3 hours from us in the house that i grew up in. as time goes on (and we all get older), i would like to persuade them into selling their modest 3 bedroom home and move closer to us. this would be beneficial in that we would have a safety net for babysitting and that type of thing, but also in that we would be close at hand if and when they need to start leaning on us as they get older. in financial terms, i thought it would be about a wash if they moved out of their home and moved into an apartment. where we live, real estate taxes are around 2-3% and insurance is probably around another 0.5% or so, but i thought that it was relatively conservative to say that they are paying about 3% all in with insurance, taxes, and maintenance. but, because of various homestead exemptions and caps, this is actually probably less than 2%. this doesn't amount to a whole lot of money out of pocket. it's certainly less than renting even a 1 bedroom apartment close by.

even so, i would like to still persuade them to make a move -- we could certainly supplement their income or provide housing, which would make the financial terms a non-factor. family matters aside, that still means up rooting them from a place where they have lived for a good number of years (again, it's the house that i grew up in) and transplanting them to a new city. it's a tough sell, but to me it has to happen at some point, so why not now?

keeping up with the joneses

i read a few personal finance blogs and subscribe to some magazines and all too often i read something about how someone is doing relative to some benchmark. it's great for stats, but in the end, the question that you have to answer is whether you have enough money to live how you want to live in retirement.

a good friend of mine does really well financially and he has this annoying trait of trying to talk salary with everyone to see where he stacks up (generally, he's at the top) -- and he's very competitive about it. he takes it very seriously that his salary is largely a measure of his success in life. well, we all know that people have very different values and some careers just don't pay like they should -- people get into teaching, social work, and a lot of other careers for rewards that are likely worth more to them than cold hard cash (which is not to say that teachers and social workers and what-have-you shouldn't be paid more).

in the end, what you earn is not nearly as important as what you spend, and what you spend isn't nearly as important as what you save. because one day, we're all going to be retired and not making a lot of money. so, ultimately we'll all be at the same end of the salary measuring stick (we'll all be making $0 from our non-existent employers, hopefully), so it's probably not worth obsessing about keeping up with your neighbors, friends, or the joneses. you just have to keep up with you and how you want to live.

if i had a million dollars

so, i read somewhere recently that if you'd like to have a million dollars at retirement age (whatever that means) that you need to have $160,000 in investments by age 40. sounds sort of fuzzy to me -- i only came across it while browsing the web, so i don't have the exact source. it got me to thinking, though, about this fascination that we have about the million dollar mark. i mean, most of us can probably get by with far less than a million bucks at retirement. it all depends, of course, on your lifestyle and spending.

in talking to my wife the other day we spoke about retirement and how much of a fund that we would need. we'd like to be able to travel a bit, spend time with our families, dine out -- we're really not extravagant people. if we had a million dollars and our house was paid off, i'd certainly think that it would be very, very easy to retire. i figured, even at a modest 5% interest, we would be able to draw about $50,000 per year (before taxes) from this imaginary nest egg without touching any principal. but, what's the point in that? and, what's a reasonable amount of spending to budget in retirement?

i ran some calculations and i came up with this -- a $500,000 nest egg earning 5% would last over 20 years if we were withdrawing about $37,500 (that's the $50,000 from above after taxes) per year. that's with no other income what so ever, except for the retirement nest egg. since i don't keep a very tight budget, i can't tell you exactly how much we spend today, nor can i tell you what a dollar today will buy in 20 years . . . that's not really my point.

really, what i am getting at is this: a million dollars is just some imaginary line that some people make a big deal over. some of us could get by easily with a million dollars, others can spend that in a month. so, what it really comes down to is what each of us personally needs in retirement. unless it's really important to you, don't get hung up on the $1,000,000 mark, but instead, focus on your personal number: $500,000, $100,000, or whatever that number may be.

retirement income

i posted a few weeks ago that i thought it was seriously out of line that common knowledge says that you need 85% of your pre-retirement income in retirement. i figured it was maybe a good rule of thumb, but still, seemed way out of line. in retirement, you've hopefully paid for your home and have a lot of the 'growing up' expenses out of the way -- putting your kids through college, buying new cars, etc.

well, i finally came across an article that backed up my notions: scott burns wrote an article about the exact same thing a week or more ago.

one of the more salient points mentions this:

In fact, if you are married, had and educated children, financed the purchase of a home or paid off student loans, odds are the 70 percent to 85 percent rule doesn't apply to you.

That's a lot of people.

a whole lot of people, i'd say. it's definitely something that i'm aiming for in my own life and certainly something that i'd venture to say that a good number of people across the nation and the world would say the same about.

it certainly doesn't mean that we'll be able to live off a meager retirement fund, but it does take some of the emphasis off the big numbers that we've seen in the past.

millions made simple

i was thumbing through men's health today and came across some financial advice by ben stein, an article entitled millions made simple. i consider myself a fan of mr. stein -- i think he's a smart guy who has probably done pretty well for himself -- so, i dove in and read the article.

for the most part, everything he says is true, but what it really tells you is what to do, not how to do it. for instance, he mentions that if you are 30 and making 50k a year and you expect to live until you are 80, you'll need 270k a year between 65 and 80, or $4,000,000. that sounds like a lot of bucks. of course, he's adjusting for inflation -- 50k in today's dollars will be roughly equivalent to 300k 35 years from now. fair enough, but it's really hard to come to terms with those figures. but, how the heck can i get my hands on 4 million dollars?

i guess the advice in the article that is closest thing to a 'how-to' is his 5th step -- keep on buying. what he is refering to is, of course, buying broad index funds, consistently and essentially forever. based on a 8% average return, this is the way to take part in compound interest and have your money work for you.

hey, it's great advice, and it'll even turn you into a millionaire if you have enough money and enough time, but $4 million still sounds like a lot of dough, and i'm going to need more help if i'm going to make it.

who wants to be a millionaire

i just read an article in the paper that indicated that there are roughly 2.9 million millionaires in the united states today. that translates roughly to 1% of the us population and puts you in some decent company, especially considering the awful savings rate of us americans. now, a million bucks is a good deal of money, but it doesn't mean that you can simply go hog wild and forget about your finances.

i once estimated (in my younger days) that i would need about 2 million dollars to retire -- i could easily live off the interest and not have any financial worries. i don't remember what i used as a rate of return or rate of inflation, but it still seems like something that would be easily doable. heck, if you're making a relatively safe 5% on that, you'll have 100k in spending cash each year without having to tap into your nest egg, though to be honest, i probably estimated earning closer to 10% on it.

i've come to my senses, though. while having 2 million dollars available to fund my retirement would be nice, it certainly is not a goal of mine. my goal in retirement is to have an account that i can safely make withdrawals from for the rest of my life. how large this fund needs to be depends on my expenses. if i could live off of $25,000 per year, a fund of $500,000 might be what i need. if i needed $100,000 per year, i'd need a significantly larger account to start from. the bottom line is that i won't be living off interest entirely. my retirement account will continue to earn interest, but i'll also likely be eating away at the principal, so i'll have to have some solid data about how much i spend to know how long my money will last.

to that end, i've had to break out of the typical paycheck to paycheck mentality. fortunately for me, i was able to break out of that mold many years ago and start building something for my future. now, how about you?

retire early

i was talking to my mother-in-law over the weekend about retirement. she had been looking over the obituaries in the paper and was just mortified to see how young people are passing away. all the time i've known her, she's always been working at 100 mph, but this weekend she expressed a desire to retire early. mainly, she came to this conclusion by looking at it from a very pragmatic angle -- if you live until you are 70 and retire at 65 and spend 2 years bedridden at the end of your life, how are you going to enjoy your 3 years in retirement?

i think it's a fine point. if you suppose that you enter the workforce at 25 and use the age of 70 as potentially stopping point, i'd say retiring at 50 would be pretty worthwhile. that would give you 25 years working and 25 years to enjoy the fruits of your labor.

based on this conversation, i'd like to be able to retire within the next 10 years, at which point, maybe i'd change careers or do something part-time. it just doesn't make sense to work so long into your life.

how to rest easy in retirement

when i was 25, i thought i'd retire a millionaire at 30. at a more conservative 30, i figured i'd be a millionare by 45. now, while i'm pretty sure that i'll be a millionaire at some point, the exact date seems to slide.

at 25 i wasn't too concerned with retirement accounts -- that stuff is for old ladies, i thought -- and besides, i wouldn't be able to get at that money until retirement age without some stiff penalties. i didn't care about it then because i was going to build a company that would change the world. i worked some crazy long hours back in my 20s and spent quite a lot of cash blowing off steam (i would reason that it was necessary after those crazy hours), and didn't contribute much at all to my retirement . . . why bother, when i'd have enough money after i cash in on the next big thing?

5 years later after basically treading water retirement-wise and not being part of the next big thing, i started paying closer attention to my retirement accounts. i started contributing 10% of my income to my employer's 401k plan and maxed out contributions to my roth ira. while it's not a huge nest egg, it's at least a nice place to put money for my old age.

401k plans (and iras) are nice in that they are tax deferred. you get a break on your taxes today because they reduce your taxable income -- you pay taxes when you take the money out in retirement. the thinking is that you're in a higher tax bracket today when you're making money than in your salt-and-pepper days when you're not working. pretty sound reasoning. employers often make matching contributions, too, which is essentially free money.

roth iras (and roth 401ks) are a bit different. you put after-tax dollars away, but the money grows tax free, making it a perfect vehicle to experience the magic of compound interest. if time is on your side, i don't know that you can beat that kind of magic.

i've heard of a method where you pay your children and have them contribute their earnings to a roth ira. i know there is some speculation out there about this, but to me it sounds like the perfect way to help them save for retirement. it would require you to actually pay your children -- that is, you would have to submit a 1099 or w-2 tax form to them and the irs for work that they have done. they would have to file taxes as well, but now that the legalities are out of the way, they can contribute those earnings to a roth ira. even with the most conservative portfolio, because they have time on their sides, their contributions would likely be worth well over a million dollars when they reach retirement age. there are all sorts of calculators and things online to predict this . . . try one with one or two contributions at age 13 or 14. that's the power of compound interest.

so, now all i have to do is build a turn-back-time machine, go back in time to when i was a kid, get the roth ira on the books (it didn't exist back then), convince my parents to pay me for household chores (ha!), contribute to a roth, convince my past self not to break into that roth for any reason, and return to the present . . . and i'd be able to rest easy in retirement.